Rittenberg/Schwieger/Johnstone
Auditing: A Business Risk Approach
Sixth Edition
Chapter 16
Completing the Audit
Copyright © 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo,
and South-Western are trademarks used herein under license.
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Assessing the Quality of
the Audit
Analytical review
Required by GAAS
Do company results make sense in relation to
industry and economic trends?
Concurring partner review
Independent review by experienced auditor who is not
part of audit team
Sarbanes/Oxley Act requires for audits of public
companies
Partner rotation
Sarbanes/Oxley Act requires new audit engagement
and concurring review partner every 5 years
Does not apply to CPA firms with less than 10
partners and 5 public company audit clients
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Other Considerations in the Final Review
Stage of the Audit: Contingencies
Contingent losses that are both probable and reasonably estimated
should be accrued and disclosed
Contingent losses that are reasonably possible, and remote
contingencies disclosed because of common practice, should be
disclosed in the notes to the financial statements
Contingencies include:
 Collectibility of receivables and loans
 Product warranty liability
 Litigation, claims, and assessments
 Threat of expropriation of assets in a foreign country
 Guarantees of debts of others
 Purchase and sale commitments
 Agreements to repurchase receivables that have been sold
 Obligations of banks under standby letters of credit
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Contingencies
Responsibilities
Management is responsible for identifying, evaluating,
and accounting for contingencies
Auditor is responsible for determining client has
properly identified, accounted for, and disclosed
material contingencies
Sources of Evidence
Primary sources include management and client's
legal counsel
Additional sources include corporate minutes,
contracts, correspondence from government
agencies, and bank confirmations
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The Letter of Audit Inquiry
Primary source of corroborative evidence concerning
litigation, claims, and assessments is the client's legal
counsel
Letter of inquiry should include
 Management's list that describes and evaluates its contingencies
 A request that the attorney furnish auditor with the following:
 Comment on the completeness of management's list and
evaluations
 For each contingency,
 Description of the matter, progress to date, and action client intends to
take
 Evaluation of the likelihood of unfavorable outcome and estimate of
potential loss, if possible
 Any limitations on the attorney's response
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The Letter of Audit Inquiry
(continued)
The letter of inquiry is good for establishing
completeness of potential liabilities and providing
factual information about contingencies
However, because audit workpapers are not
privileged, attorney responses will be less than
forthcoming about the likelihood of unfavorable
outcomes, and the estimated amount of any
potential losses
An attorney's refusal to provide the requested
information is a scope limitation sufficient to
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preclude issuing an unqualified opinion
Adequacy of Disclosures
Third standard of reporting states "Informative
disclosures in the financial statements are to be
regarded as reasonably adequate unless
otherwise stated in the report."
Auditor must be sure that:
Disclosed events and transactions occurred and
pertain to the client
All disclosures that should be included are included
Disclosures are understandable to users
Disclosures are accurate
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Management Representations
Management Certification of Financial Statements
Sarbanes/Oxley Act requires CEO and CFO to certify
financial statements are fairly presented in accordance
with GAAP
Auditor should review management's processes for
certification
Management Representation Letter
Reminds management of its responsibility for the
financial statements
Confirms significant oral responses made by
management
Reduces possibility of misunderstandings between
management and auditor
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Management Representations
(continued)
Letter is prepared by auditor on client letterhead,
addressed to the auditor, and normally signed by
CEO and CFO
Letter is dated as of the audit report date (end of
fieldwork)
Because management representations are not
strong evidence, the auditor should perform
procedures to corroborate the information in the
letter
Management's failure to provide this letter is a
scope limitation sufficient to preclude issuance
of unqualified opinion
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What is the management
comment letter?
Auditors often notice things that might make the
client more profitable
Many of these observations related to control
deficiencies or operational matters
The observations are included in a management
comment letter typically delivered to the Board of
Directors with the audit report
Management letter is not required, but does add
value to the audit
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What is the going concern
issue?
Auditor is required to evaluate client's ability to
remain a going concern for a period not to
exceed one year from the balance sheet date
Indicators of potential going concern problems
include
Negative trends in key financial areas like cash flow,
sales, profits
Internal matters, such as loss of key personnel, and
outdated facilities and/or products
External matters, such as new legislation, loss of
significant customer or supplier, uninsured casualty
loss
Other matters, such as loan default, inability to pay
dividends, attempted debt restructuring
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What is the going concern
issue? (continued)
If there is substantial doubt about ability of client to
remain a going concern, auditor should
Discuss the situation with management
Assess management's plan to overcome problems
Consider the effects on the financial statements
Auditor should evaluate the adequacy of financial statement
disclosure
Disclosures might include conditions causing the going
concern doubt and management's plan to overcome the
problem
Consider the effects on the audit report
Add explanatory paragraph to the unqualified audit report
Disclaim opinion
Issue qualified opinion if disclosure is not adequate
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Review of Significant Estimates
Management estimates provide opportunities for the entity to
"manage" or even manipulate earnings. The auditor provides
reasonable assurance that - Management has information
system to develop estimates material to the financial statements
 Estimates are reasonable
 Estimates are presented per GAAP
In evaluating management estimates, the auditor concentrates on
key factors and assumptions that are
 Significant to the accounting estimate
 Sensitive to variations
 Deviations from historical patterns
 Susceptible to misstatement
 Inconsistent with current economic trends
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Communicating with the Audit
Committee
Items the auditor should discuss with the audit committee
include
 Auditor's responsibility under GAAS
 Management judgments and accounting estimates
 Audit adjustments
 Uncorrected misstatements
 Accounting policies and alternative treatments
 Major accounting and reporting disagreements with management
 Difficulties encountered in performing the audit
 Copies of significant communications between auditor and
management
 Management's discussion with other CPA firms
 Significant fraud or illegal acts
 Significant deficiencies in internal control
 Any independence issues
 Any other significant matters
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What are subsequent events?
Subsequent events occur after the balance sheet date.
Audit procedures used to identify subsequent events
include:
 Read minutes of meetings of the board of directors,
stockholders, and other authoritative groups held after year-end
 Read interim financial statements; investigate significant
changes
 Inquire of management about
 Significant changes in noted in interim statements
 Significant contingent liabilities
 Significant changes in working capital, debt, or owners' equity
 Status of any tentative items
 Unusual accounting adjustments made after balance sheet date
 Inquire of management and legal counsel about subsequent
events
 Obtain management representation letter
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Subsequent Events (continued)
How an auditor handles a subsequent event
depends on two things:
Whether the subsequent event provides
evidence about conditions that existed at the
balance sheet date (type 1), or conditions
arising after the balance sheet date (type 2)
When the subsequent event occurred: during
fieldwork, after fieldwork but before the audit
report has been issued, or after the audit
report has been issued
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Subsequent Events (continued)
Types of Subsequent Events
Type 1 subsequent events provide evidence about
conditions that existed at the balance sheet date
The financial statement numbers should be adjusted to
reflect this information; footnote disclosure may also be
necessary
Examples of type 1 subsequent events:
 Major customer files for bankruptcy during subsequent period, its
deteriorating financial condition existed prior to the balance
sheet date
 Lawsuit settled for different amount than accrual
 Stock dividend or split during the subsequent period
 Sale of inventory below carrying value when loss occurred
during the subsequent period
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Subsequent Events (continued)
Type 2 subsequent events provide evidence about
conditions that did not exist at the balance sheet date
The financial statement numbers should not be adjusted for
these events, but they should be considered for disclosure
Examples of type 2 subsequent events:
 Uninsured casualty loss that occurs after the balance sheet date
 Significant lawsuit initiated for incident occurring after the balance
sheet date
 Significant loss due to natural disaster occurring after the balance
sheet date
 Major decisions made during the subsequent period such as
decision to merge, discontinue a line of business, or issue new
securities
 Material change in value of investment securities after the balance
sheet date
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Subsequent Events (continued)
If subsequent event occurs after end of
fieldwork but before audit report is issued,
auditor must decide whether to single or
dual date the audit report
Single date
Date of subsequent event is the audit report date
Auditor must make sure there are no other
subsequent events prior to report date
Dual date
Use dates of end of fieldwork and subsequent
event
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Subsequent discovery of facts existing
at the date of the auditor's report
Auditor must determine
Reliability of new information
Whether the event had occurred by the audit
report date
Whether users are likely to still be relying on
the financial statements
Whether the audit report would have been
affected had the facts been known
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Subsequent discovery of facts existing
at the date of the auditor's report
If the auditor decides further reliance on the financial statements
and audit report is not appropriate, client is advised to make
appropriate and timely disclosure of these new facts
Appropriate actions:
 Revise financial statements and audit report
 Revision and explanation reflected in subsequent period
financial statements
 If revision will take extended period, notify users that statements
and audit report should no longer be relied on
If client will not cooperate, auditor should
 Notify client and regulatory agency that the audit report should
no longer be associated with the financial statements
 Notify known users that the audit report should no longer be
relied on
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